Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

Preface to the Second English Editionxxxiits rapid collapse, and with it the sudden monetary squeezewhich would be inevitable if, in an environment of widespreadbroken trust among depositors, a significant volume ofbank deposits were to disappear. This short-term goal, whichat present, western governments are desperately striving forwith the most varied plans (the massive purchases of “toxic”bank assets, the ad hominem guarantee of all deposits, or simplythe partial or total nationalization of the private bankingsystem), could be reached much faster and more effectively,and in a manner much less harmful to the market economy, ifthe first step in the proposed reform (pages 791–98) wereimmediately taken: to back the total amount of current bankdeposits (demand deposits and equivalents) with cash, bills tobe turned over to banks, which from then on would maintaina 100-percent reserve with respect to deposits. As illustrated inchart IX-2 of chapter 9, which shows the consolidated balancesheet for the banking system following this step, the issuanceof these banknotes would in no way be inflationary (since thenew money would be “sterilized,” so to speak, by its purposeas backing to satisfy any sudden deposit withdrawals). Furthermore,this step would free up all banking assets (“toxic”or not) which currently appear as backing for demanddeposits (and equivalents) on the balance sheets of privatebanks. On the assumption that the transition to the new financialsystem would take place under “normal” circumstances,and not in the midst of a financial crisis as acute as the currentone, I proposed in chapter 9 that the “freed” assets be transferredto a set of mutual funds created ad hoc and managed bythe banking system, and that the shares in these funds beexchanged for outstanding treasury bonds and for the implicitliabilities connected with the public social-security system(pp. 796–97). Nevertheless, in the current climate of severefinancial and economic crisis, we have another alternative:apart from canceling “toxic” assets with these funds, we coulddevote a portion of the rest, if desired, to enabling savers (notdepositors, since their deposits would already be backed 100percent) to recover a large part of the value lost in their investments(particularly in loans to commercial banks, investmentbanks, and holding companies). These measures would